Finances and trading is a very complicated industry thanks to the many factors that directly affect the values in it. To offset that, history has given birth to several tools for traders to identify tendencies and clues that can help them to predict what will happen next. Thanks to these tools, investors around the world have been able to manage risks and choose the correct assets in which to invest, making them fundamental for success.
And, one of those tools is what’s known as a price channel.
What is a price channel?
A price channel is an indicator.
Indicators are “add-ons” for charts that allow for people to have a better view on what they say. They are used to measure the conditions in the market, giving the right signals and symbols to understand said conditions.
Any trader worth his money can identify when certain indicators are better than others, as each one is better for specific goals.
In this case, we are talking about price channels, which are often used for identifying trends and possible directions to be taken by an asset’s value.
- Why are they important?
The first thing that anyone expecting to trade, whether stocks, FOREX, or cryptocurrencies is that value is completely subjective.
What drives the price of anything is how much people believe that asset is worth. It is because of this principle that investment and trading are profitable career choices; what you paid for something today can be half the amount for which you can sell it next week.
Understanding how these factors function can be a hard task. You must be able to identify, in a graph, the most significant price swings and pivot points. That’s something that rapidly becomes tough as soon as you notice how fast those graphs become crowded with numbers.
That’s the reason for the importance of price channels, they give you a simplified view of the overall direction of an asset’s value.
- How do they work?
Price channels are divided in three main parts, two parallel lines and the space between them (which can include a line).
Each part of the indicator has its own task that, when combined, makes the indicator work the way it does.
- Upper Line.
The upper line identifies resistance levels of an asset’s price.
What that means is that it provides a clear view of the highest price paid for an asset before the value starts diminishing.
- Lower Line.
The lower line in a price channel is used to recognize support levels.
Support levels are the lowest price an asset is sold before its value starts increasing. Essentially, it’s the “bouncing” point.
- Middle Line or Channel.
Between both lines lies the spectrum of worth for any financial instrument.
If the channel contains a line in the middle (which often does), then it shows the average cost. The usefulness of this specific line is that lets traders have a specific point for estimating loses or gains.
All these components form an easy-to-spot indicator for trends. By observing how the tunnel moves, any investor can see how the market has grown or decreased over time.
With that information, breakout points and future price swings can be better predicted.
- How Can You Use Them For Trading?
Price channels show market trends and growth, making them exceptionally useful for identifying where it will go next.
Each trend, whether it’s upwards or downwards, can either keep going or change its direction. In other words, there are only two ways these types of trends can move, maintained or reverse.
Price channels are used to estimate the probability for both outcomes. Once you have a solid estimate, you may use them for different strategies.
One of said strategies, as pointed out by DailyFX, is to use them for breakout trading. In short, breakout trading means entering a trade once prices have “broken out” of their previous levels.
Once an asset’s value has surpassed previous supports or resistances, it’s a strong sign that a reversal is about to happen. Breakout traders look to sell after a price has passed through the upper line; additionally, they strive to buy assets after they’ve passed previous lower lines.
This is made easier since price channels reduce the amount of gambling entailed by predicting future outcomes.
What we can take from this quick guide is that price channels are one of the best choices for estimating trends and acting accordingly.
What must be kept in mind, though, is that indicators are not instant signals for action. They provide clues and an easier understanding of the information in the charts. However, any trader must be wary of taking indicators as the complete truth for operations.